It has become clear to everyone in the financial world that the monetary policies pursued by central banks have completely failed in their objectives.
Central bankers carry on regardless, continuing to ride the speeding money-train to the end of the line, a train from which jumping risks serious injury. Independent economists not working for a central bank would be blind not to see the failure, so some of them are thinking up imaginative solutions.
There is a problem with their approach. While recognising the failure, in their attempts to find alternative solutions they use the same macroeconomic principles that led to the failure in the first place. Let us turn to a classic example of the genre, which is wholly in the public domain. Adair Turner, in a paper presented at a conference hosted by the IMF last November, recommends what he calls monetary finance. Lord Turner puts forward a scheme whereby the US Government spends money into the economy without creating government debt. Furthermore, he proposes that existing government debt on the Fed’s balance sheet be swapped for a non-interest bearing, non-redeemable “due from government” asset.
This isn’t the only way Lord Turner sees money being made to rain down upon us, but you get the idea. He is of the opinion that this would be a one-off to kick-start the economy out of deflation, and he is confident it would work because he implies the theory is not in doubt. He says it is therefore a matter of political will, but if it does not work for some unexpected reason, the US Government should introduce a set of rules so that it can be used again, with checks and balances of course. Keep riding that money-train!
Lord Turner’s belief that the economics are unarguable illustrates the myopia of modern macroeconomists. It is not clear whether he dismisses Austrian economic theory because he is unaware of it, or on the grounds of his committed belief in the cutting-edge of post-Keynesian neo-classicism. This makes his recommendation in favour of monetary finance look like yet another triumph of hope over experience. Furthermore, it will be too tempting for any government to continue to raise money without apparent cost, if rules for using monetary finance are introduced. It is always, always, always justified as “in the national interest”. On this point Lord Turner appears naively trusting.
I have never had a straight answer from macroeconomists as to why they think that impoverishing the overwhelming majority of people by the continual debasement of both their savings and the purchasing power of their wages must result in a stronger economy. Debasing the currency to fund a series of quick fixes has always been the intention behind monetary policy, and this proposal is just the latest example. The fundamental flaw underlying the argument is increasingly desperate attempts to stimulate aggregate demand. The only time stimulation of aggregate demand has succeeded beyond the confines of an individual credit cycle is under a full command economy, where people are instructed, at risk of state penalty, what to produce and consume, and the means of economic calculation, money, is taken out of the equation.
Stimulating aggregate demand doesn’t even work within a credit cycle, when you take fully into account the temporal progress of monetary debasement and the eventual adjustment of prices. Suppressing interest rates doesn’t work either, because all that happens is demand is made to shift from current to deferred consumption, introducing distortions into an economy that might look like a positive result.
This is where advocates of managing aggregate demand are particularly wanting. They would have us believe potential economic growth is reduced by increases in savings, but if the statisticians stopped underreporting the economic benefits of investing in higher orders of production, the role of savings in an economy might be better understood. This point has been partially conceded in America with the quarterly publication of gross output, which includes the intermediate actions that characterise the assembly of capital equipment. This investment in improved production is the destination of a large part of our savings, and if it is underreported, the value of savings is unlikely to be appreciated.
Gross output is unfortunately rarely conveyed by the financial media, but no amount of repeating facts such as gross output is enough to persuade neo-classical economists to drop their cherished demand-management beliefs. This is why many of them are now changing their focus from monetary to fiscal stimulation. Like a dog with its bone, they refuse to give up, and the policy recommendations of economists such as Professors Krugman and Summers may be about to enjoy a renaissance.
This is also the thrust of Lord Turner’s argument. He argues that the limitation of debt creation should not apply to government spending. He recognises in effect that debt-financing is reaching the end of its road, so instead of accepting market-imposed limitations on government spending, we should find ways round them. Monetary finance is presented as a new approach, but apart from operational detail it is all old hat.
It is a variant of the trillion-dollar platinum coin proposal to fix the debt ceiling, which surfaced two years ago. The idea was to exploit a legal loophole that allows the US Government to issue an ordinary platinum coin with a trillion-dollar face value, which when deposited at the Fed gives the government a one trillion-dollar credit. With both this and Lord Turner’s schemes, the Fed ends up with a balance sheet which incorporates an enormous amount of goodwill in the US Government.
Technically, it works. After all, it is hard to see on what grounds an auditor would have the temerity to question the arrangement, given the supremacy of the US Government. Furthermore, a similar arrangement is already in place with a note from the US Treasury representing 8,134 tonnes of gold, valued today at $325bn. No one knows if the gold actually exists: it could be all gone, but what auditor would dare question the validity of an IOU from the Treasury?
Except, the Fed has no auditor.
The monetary finance scheme depends on two categories of victims going along with it. The first is the American people, who rarely question monetary matters which they barely understand, and the second is foreigners, who might just take fright. Schemes such as monetary finance and trillion-dollar platinum coins reek of financial desperation. They are likely to be met with a downgrading of the US Government’s much vaunted full faith and credit, accelerating a move away from the dollar as the world’s sole reserve currency. If the scheme is introduced, it will be at the same time as the Fed is pushing through its covert media channels an argument that folding cash should be done away with, other than for small denominations. The largest holders of dollar cash are foreigners outside America, and it doesn’t take much imagination to see the circumstances where those dollars might be ditched for other currencies, and sometimes gold.
As already stated, schemes such as monetary finance and platinum coins are designed to stimulate aggregate demand, and it is assumed that a return to price inflation of a level such as two per cent can be taken as evidence of success. This is a bad mistake, based solely on the quantity theory of money, which demonstrably applied to gold in Cantillon’s and Ricardo’s days, but is a secondary effect in fiat currencies. Lord Turner fails to make this distinction.
The overriding determinant of purchasing power today is public faith, expressed by the relative preference between holding money and goods. A small shift in this preference is all that’s required to materially alter the general level of prices, without any significant change in economic activity, because both consumers and producers, who are simply different facets of the same people, want to hold less money. This is why central banks have great difficulty in controlling the outcome of monetary policy.
Macroeconomists are making another mistake in their diagnosis of economic problems. By focusing on nominal GDP, they are merely measuring the injection of extra money into the economy, not its productive use. What they miss is that most people go about their daily business, making things and spending the bulk of their salary, while saving a little. The problem arises when the monetary authorities and the commercial banks start messing around with money, the means of economic calculation, leading to false booms and inevitable busts. It is monetary intervention and the macroeconomists that are the underlying problem, not the economy.
However, continual intervention over the decades has led to an escalation of debt. Debt has been building to the point where it is now uncomfortable for too many economic actors, a discomfort which is no longer eased by lower interest rates. It is monetary meddling that has driven the US economy into a debt trap. And being a good statist, Lord Turner thinks he has found a way out for the government, but fails to address the problem in the private sector.
If something on the lines of monetary finance is adopted, presumably central bankers will hope that it will eventually lead to more normal interest rates. The level of normality is impossible to know without market input, but if we assume central bankers think it equates to a Fed Fund Rate of somewhere between three and five per cent, the implied borrowing costs would erode government finances dramatically, because of its dependence on short-term debt. Similarly, bad debts would escalate in the private sector.
In conclusion, Lord Turner’s proposal for monetary finance does not hold water. The dollar looks like it has already topped, if gold as a leading indicator is any guide, in which case a combination of banning large-note cash and monetary finance are more likely to collapse the dollar than stimulate aggregate demand.